Minimizing loss: Run-length trade statistics

An enormous amount has been written about the psychology of trading. Indeed, many experienced traders claim that trade strategy and execution are less important than managing the emotions of trading. This doesn’t mean, however, that you’ll find all the answers from your psychiatrist’s couch. Instead, we can embark on a critical journey to understand the basic statistics of trading — for example, the frequency and duration of winners and losers — to better navigate and anticipate the ups and downs of the trading endeavor.

Consider a simple automated intraday strategy that fades the previous day’s highs and lows. The strategy runs against the Chicago Mercantile Exchange’s E-mini S&P 500 futures contract (ES); it could be applied to a variety of assets. A long position is taken when the market retraces to the previous day’s low; a short position is taken when the market retraces to the previous day’s high. Logic is added to handle opening gaps above and below these levels, and trades are not taken when the underlying stock market, as measured by New York Stock Exchange breadth data, is either too bullish or bearish, indicating a trend may be in progress. Initial stop-loss is set at 0.5% of contract value and trailing stops are used if a 0.5% contract profit is realized.

“Equity rising” (below) gives the most recent three-year performance of the strategy, trading a single ES contract, where the intraday margin requirement typically is $500. For the most part, this is in-sample data and must be viewed as such; however, the equity curve’s last year was collected as an out-of-sample test and arguably is a reasonable reflection of the strategy’s efficacy.